The Supply-Side Effects of Monetary Policy

David Baqaee, Emmanuel Farhi and Kunal Sangani

Journal of Political Economy, 2024, vol. 132, issue 4, 1065 - 1112

Abstract: We propose a supply-side channel for the transmission of monetary policy. We show that when high-markup firms have lower pass-throughs than low-markup firms, then positive demand shocks, such as monetary expansions, alleviate cross-sectional misallocation by reallocating resources to high-markup firms. Consequently, positive “demand shocks” are accompanied by endogenous positive “supply shocks” that raise productivity and lower inflation. We derive a tractable, four-equation model where monetary shocks generate hump-shaped productivity responses. In our calibration, the supply-side effect amplifies the total impact of monetary shocks on output by about 70%. We provide empirical evidence validating our model’s predictions using identified monetary shocks.

Date: 2024
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Related works:
Working Paper: The Supply-Side Effects of Monetary Policy (2021)
Working Paper: The Supply-Side Effects of Monetary Policy (2021)
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